When U.S. Federal Reserve chief Ben Bernanke pulled his latest confidence-restoring tonic out of his medicine bag last week, he could not have been expecting such a strongly adverse reaction from the markets, which practically choked on the stuff.
Investors simply concluded that if the Fed is desperate enough to try bringing down already ridiculously low long-term interest rates – in what one wag dubbed "Operation Twist in the Wind" – the beleaguered U.S. housing market and the broader economy must be in as bad shape as the bearish prognosticators have been telling us. And if that's the best the U.S. central bank can do, it must really be out of ammunition.
Among those feeling the market letdown most acutely are big pension funds, which have yet to recover from the last global financial crisis and are one of the little noticed victims of the extended rock-bottom interest-rate policies of major central banks.
"Pension funds are getting badly hurt again," says Peter Lindley, who runs the Canadian arm of State Street Global Advisors, a major institutional adviser.
Indeed, a study finds that the median U.S. corporate pension plan faces a larger funding shortfall today than in the midst of the last financial crisis in 2008-09. "I wouldn't be surprised if many Canadian pension plans are in similar straits," Mr. Lindley says. "That's quite a frightening thing, because it reduces the amount of risk that they can bear."
There was a time when pension funds and other institutional investors paid little heed to the hot air emanating from the corridors of political power. But those days are gone. It was not Europe's festering debt crisis that combined with the latest Fed intervention to spook the markets last week. It was the continued foot-dragging and general bungling by politicians who don't seem to grasp the painful lessons of 2008, even at this late date. The same holds true for Washington, where corralling the deficit and fixing the economy have taken a back seat to scoring ideological points.
"There's a lot of nervousness in the markets, because we've moved out of the realm of what we're used to," says Mr. Lindley. "We can deal with a recession. We can deal with problems. But I'm not sure we can feel comfortable making investments based on what we hope or think an official may or may not do from one minute to the next. There is this massive exposure to policy right now."
Just three months ago, "we were talking about what-if contagion," Mr. Lindley says. And now, it's plainly here, as illustrated by the credit downgrades of banks in France and Italy, not to mention Italy itself.
Pension managers are finding their options are becoming more limited. "You're in a situation where you can't take as much risk. But there's no way to get the returns that you need either. So you're in that chasm that's very difficult to get out of."
This could become a serious drag on profits, as companies are forced to pump in more capital to bring their pension funds back to solvency. The entire economy will suffer, as capital that might have gone into new investments gets diverted.
So far, most institutional investors "are still hoping to ride out the storm," Mr. Lindley says. "The ongoing bailouts of markets by policy makers have created dependence by some investors, who, rather than adjust their investments to reflect a worsening economic situation, are waiting to be saved by some massive stimulus package."
Yet developed economies can no longer afford such asset-inflating policies.
Meanwhile, despite the markets' loss of faith, the policy makers are still attempting to sound the right notes. After the latest Group of 20 gabfest in Washington, they declared their commitment "to a strong and co-ordinated international response to address the renewed challenges facing the global economy."
And the Europeans finally seem to realize that kicking the Greek can down the road is not a viable strategy. They are speeding up the timetable for recapitalizing 16 shaky banks and implementing a permanent rescue fund.
Regardless of whether these efforts calm the rattled markets, Mr. Lindley's advice remains the same.
"We continue to advise our clients to manage their investments in line with their ability to bear risk and try to minimize any unintended risks through more closely aligning their assets and liabilities," he says. "If you cannot afford to lose a large amount, don't bet a large amount in risky assets."
That sounds like a sensible approach for the rest of us, too.